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Key takeaways

Review your essential and discretionary expenses.

Make smart use of unemployment and savings, severance, or disability money.

Formulate a withdrawal strategy that is sensitive to tax considerations.

For some, retiring early is a dream. But for those faced with an unplanned early retirement—they are laid off late in their career or have a medical disability—it may be a different story, especially if you are not yet eligible to claim Social Security beginning at age 62.

"Many people plan to work well into their 60s, but the reality is that you don’t always have control over when you retire," says Ken Hevert, senior vice president of retirement products at Fidelity. "That's why careful planning is so critical if you find yourself in this situation, especially when it comes to timing your Social Security benefits."

The good news is that there are ways to help bridge the gap between when your paycheck stops and when you start taking Social Security—or go back to work.

While you may be eligible to begin taking Social Security at age 62, that might not be the best decision, even if you aren't working. That’s because after you reach age 62, every year that you delay taking Social Security (up to age 70), you could receive up to 8% more in future monthly payments. (Once you reach age 70, increases stop, so there is no benefit to waiting past age 70.) Also, delaying your own Social Security may increase your spouse's survivor benefit.

If you find yourself unintentionally retired for any reason, first use the 3 key steps outlined below to assess your situation and income options. Then, take a look at 2 "bridge" strategies—one if you are disabled, and the other if you are laid off. Important note: If you're in this situation, you'll be making significant financial decisions and should consult with a financial advisor before doing anything.

Assess your financial situation

Step 1: Start with your budget

Review your essential and discretionary expenses and then compare them to your income. Start by zeroing in on your monthly expenses. Review this information dispassionately and look for places to cut. For example, it may be easier to reduce costs for dining out now that you have more time to cook, or cut back on transportation, clothing, and other items that were necessary for your job.

Step 2: Make smart use of your assets

Look at potential income sources. You might consider generating income from your home, for example, with a home equity line of credit (that you would later pay off from the sale of other assets). Perhaps you can downsize your residence (keeping in mind that selling your home may take time). If you sell and receive a substantial amount of money, consider using it to purchase a period-certain annuity (which has a defined beginning and ending date) that provides regular income until you start taking Social Security.

Step 3: Formulate a tax-smart withdrawal strategy

You may need to draw from your retirement or personal savings as well. Consider developing a strategic withdrawal strategy based on your tax bracket, which should aim to help reduce the effects of taxes while helping to potentially stretch your savings.

Traditional workplace savings plans and IRAs. Withdrawals from these accounts are generally taxed as ordinary income. Also, a 10% early-withdrawal penalty generally applies on distributions before age 59½ for IRAs and 401(k)s, unless you meet one of the IRS exceptions. If you no longer work for the company that provided the 401(k) plan and you left that employer at age 55 or later—but still maintain a 401(k) account, you can take early withdrawals beginning at age 55 without a penalty. You should contact your plan administrator for rules governing your plan. For IRAs, you can avoid the early-withdrawal penalty by arranging to take "substantially equal periodic payments" from the account. The amounts of your withdrawals are based on your age and account balance, and you must take them for 5 years or until you reach age 59½, whichever is longer. Consult with a tax advisor if you are interested in taking substantially equal periodic payments.

Roth IRAs. A distribution of earnings from a Roth IRA1 or Roth 401(k) is tax-free and penalty-free provided that you have owned your Roth for 5 years (known as the 5-year aging requirement) and at least one of the following conditions is met: You reach age 59½, make a qualified first-time home purchase, become disabled, or die. You can always withdraw your after-tax contributions penalty-free and tax-free.

Health Savings Accounts. You may have accumulated tax-advantaged money* in an HSA from a previous employer that can be used to pay for a doctor's visit or other qualified medical expenses now or in the future. Although HSAs generally cannot be used to pay for health insurance premiums, there are 2 important exceptions: paying for COBRA continuation health care coverage and paying health plan premiums while receiving unemployment compensation.

Taxable accounts, including mutual fund and brokerage accounts. If you have to sell appreciated assets in these accounts to generate cash, it may result in capital gains taxes.

If you retire early due to a medical disability

If you have to end your career for medical reasons, you may be eligible to receive income from disability insurance. Coverage may come in one or more of the following forms, and knowing your options has important implications for your financial plan.

Employer-funded disability. Payouts from these policies generally replace about 60% of your income, which can leave a significant gap. Any income you receive from an employer-provided policy is taxable, and some disability insurance contracts provide funds only until you can train for work in a different career. You may be eligible for workers’ compensation, but it typically lasts only until you are physically capable of returning to work.

Privately funded disability. You may have signed up for a policy on your own if your employer didn't provide coverage, or if you wanted to supplement the coverage your company offered. Either way, payments from a self-funded disability policy are tax-free. If you have this type of plan, review your documents or consult your insurance agent for information about the duration and amount of your benefit.

Social Security disability. Qualifying for Social Security disability benefits can be difficult and time-consuming. You may want to consult a financial advisor or attorney to help guide you through the process. If you are approved to receive these benefits, be aware that your disability payments automatically convert to retirement benefits when you reach Social Security’s full retirement age (which is either 66 and 67, depending on your year of birth), and this benefit will remain the same.

Example: How the Bartons manage a medical disability

Let's look at a hypothetical couple, Jane and Michael Barton. Michael suffers from a significant medical condition at age 62, while Jane, age 60, continues working. They decide to try to wait until Michael turns 66 to take his Social Security retirement benefits, in order to receive the full monthly payment.

The Bartons had a total pretax household yearly income of $120,000 ($70,000 plus $50,000) before Michael left the workforce, meaning a $70,000 decrease in income. Yearly household expenses total $90,000 ($60,000 essential and $30,000 discretionary). In addition, the couple has $800,000 in retirement assets in a combination of taxable ($100,000), tax-deferred ($500,000), and tax-free ($200,000) accounts.

The couple cuts essential expenses by 10% ($6,000) and discretionary expenses by 30% ($9,000), bringing net household expenses to $75,000 for the upcoming year. On an after-tax basis, Jane makes $40,000, which leaves a gap of $35,000 in the first year. Michael receives short-term disability for 3 months, at the end of which long-term disability coverage kicks in. Altogether the insurance provides $30,000 after taxes for the year, so the couple needs to withdraw $5,000 per year for the next 4 years from their retirement assets (actual withdrawal will be higher as taxes are owed upon withdrawal).

This withdrawal, combined with disability insurance and reductions in expenses, fills their income gap—allowing them to reach the disabled spouse's full retirement age of 62 for Social Security.

People who face such a situation at a younger age may not be able to forego Social Security until age 66. In this case, they can build a bridge strategy that takes them to age 62, the earliest point at which they can receive Social Security benefits.

Tip: Health status, longevity, and retirement lifestyle are 3 key variables that can play a role in your decision on when to claim your Social Security benefits. You may not be able to predict the true impact of these variables, but you can rely on the simple fact that if you claim early versus later, you will likely have lower benefits from Social Security to help fund your retirement.

If you are laid off

Your income sources will be different after a layoff than they might be following a disability. The differences call for distinct strategies to provide income until you take Social Security. You may receive a lump-sum severance payment, as well as unemployment insurance. The unemployment program is run by states, and workers in most states are eligible for up to 26 weeks, although some states allow more and some fewer. The average unemployment benefit is $344 a week, according to the National Employment Law Project.

Example: How the Franklins manage a layoff

Let's consider another hypothetical couple, Amy and John Franklin. Amy is laid off at age 62, but otherwise their circumstances are similar to the Bartons in the previous example. The Franklins, however, can't count on disability insurance to replace 60% of the retiring worker's $70,000 income, so they take an even harder line on costs.

The couple cuts essential expenses by 20% ($12,000) and discretionary expenses by 30% ($9,000), bringing net household expenses to $69,000 for the upcoming year. On an after-tax basis, John makes $40,000, which leaves a gap of $39,000. Six months of severance pay and 6 months of unemployment insurance provide $30,000 in after-tax terms, so the Franklin's need to withdraw $9,000 from retirement assets (actual withdrawal will be higher, as taxes are owed upon withdrawal).

But severance and unemployment eventually run out. What's more, inflation potentially increases the couple's expenses each year. So they increase their withdrawals in subsequent years, starting with their taxable accounts.

"By combining lifestyle changes, striving to maximize Social Security, and utilizing a well-planned withdrawal strategy, the couple's nest egg may last through retirement," Hevert says.

In conclusion

If you've recently suffered a medical disability or a layoff, the future may be challenging. But you do have options, even if you don't reenter the workforce. A well-thought-out bridge strategy can help you transition between your career, retirement, and your Social Security benefits.

1. A distribution from a Roth IRA is tax free and penalty free, provided that the five-year aging requirement has been satisfied and at least one of the following conditions is met: You reach age 59½, suffer a disability, make a qualified first-time home purchase, or die. Each customer's situation, needs, priorities, and preferences are different. Financial decisions should always be made by the customer in full consultation with a tax professional.

2. This is a hypothetical example and is not intended to represent the performance of any security. For illustrative purposes only. Individual investor results will vary and may be more or less than those shown. The federal marginal bracket assumption utilized was 22% on the gross income. Example assumes no penalties apply at time of withdrawal. Roth IRA withdrawals are assumed to be qualified tax-free distributions.

This information is intended to be educational and is not tailored to the investment needs of any specific investor.

Keep in mind that investing involves risk. The value of your investment will fluctuate over time, and you may gain or lose money.

Fidelity does not provide legal or tax advice. The information herein is general and educational in nature and should not be considered legal or tax advice. Tax laws and regulations are complex and subject to change, which can materially impact investment results. Fidelity cannot guarantee that the information herein is accurate, complete, or timely. Fidelity makes no warranties with regard to such information or results obtained by its use, and disclaims any liability arising out of your use of, or any tax position taken in reliance on, such information. Consult an attorney or tax professional regarding your specific situation.

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